Trading Capital And Income Calculation

One of the questions that I get asked often at training seminars is about how much capital is required for trading and how much money one could make as a day trader. While the right answer to this is No Limit, lets try finding a more practical answer.

Knowing that the market is a place of almost infinite wealth potential, how do I set a practical figure to what I should be earning? I suggest that the best way to find that out is to look at what your qualification can get you as a salary if you were to hold down a job. Or maybe if you are not qualified enough to get a good well-paying job, then look at what some others are earning in some small business that you feel you could do as well. Lets peg that amount to 50000 per month. This is a reasonable middling amount that most beginners would make. If your averages are higher you can always rework the math. Your trading income should be equal to this.

Let us assume that we shall trade 3 times a week. That is about 12 sessions in a month. So this gives us about 4000 to be made as profits per session. The daily volatility of any stock or index is about 1 to 1.5%. Assuming a stock priced around 300-400, this would mean an average daily movement of about 4-6 points. Most of such stocks would have a trading lot size of 1000 shares. So you would need to trade one lot to capture the kind of profits that we have set out to do so. That would require you to fund the account with a margin of about 50K (minimum) to 100K.

Now let us look at the risk part of it. Normally any trading method would suggest a stoploss on such a stock at around 1%. So that would be 3-4 points of risk, making the trade a 1:1 payoff in terms of a risk to reward. This is acceptable (and cannot be less).  Now if I decide not to risk more than half a percent of my capital on every trade, then my capital has to be around 1 lac (at 4000 risk per trade). Setting this kind of risk parameter will allow you to have a losing streak of 25 trades before your capital gets wiped out. While such runs are indeed possible, the probability is low.

What about the losses that shall inevitably occur? Well, that is a function of your trading method and its efficacy. It is presumed in the above calculation that you have finalised a trading method that has a positive expectancy. Higher that number the better the system. Idea here is that one should persist with the method (since it has a positive expectancy) and the method itself should produce sufficient number of trades to ensure the profit target. To illustrate, we need 12 winning trades to reach our profit goal. If the system is operating at 40% efficiency ratio, then the system will have to throw up at least 30 trades within a month. Assuming that losing streak runs shall be larger, the system will probably have to generate between 35-40 trades per month for the profit goal to be reached. This trade requirement can then be used to decide what time frame chart is to be used to produce the trades. The overall drawdown of the system as well as the number of negative runs shall also decide whether additional capital may be required.

Thus we can see that it is not just about fixing a figure to earn. It is a complete analysis of several aspects of risk, reward, trading methodology, expectancy, drawdown and runs. You can substitute different numbers for indices and margins etc. to arrive at similar numbers. This is a business. Approach it in a business-like manner.